What's the difference between forwards and futures ?
The only material difference is that futures contracts are standardised. Every contract is the same. Same underlying, same delivery points, same size, same payment terms etc.
Whereas steel's existing forwards contracts allow individual firms to tailor the contracts to fit with their exact needs, futures contracts do not allow such flexibilities. Futures contracts are merely standardised forwards contracts.
Forwards vs Futures Prices
The forwards price - the price contracted to in your forward contract - is usually unique to that deal. So on any day you'll get a range of forwards prices for the same steel, as determined by differences in payment terms, or delivery terms, or packing, or additional testing. You'll even have different prices for the exact same volume of the exact same steel for the exact same delivery, same payment terms etc.
Not with futures. Because futures contracts are all standardised, and not subject to the tailoring of steel's traditional forwards contracts, at any moment in time there is only one price for each delivery period.
Lets just think about the price at which the steel industry's regular forwards contracts are concluded. The price in a forwards contract is the equilibrium price between what the steel mill thinks its steel is worth - the asking price - and what the buyer thinks its worth - the bid price. You negotiate to arrive at the contract price.
In a futures market, instead of
Price Credibility
So which price is a better reflection of the market ? Which price is more credible ?
Steel futures prices are not guesswork or hunches or bets. They are the direct result of informed buyers and sellers quoting, bidding, and trading contracts, with firm commitments to make or take delivery of steel. At any one time the futures price for a particular month is the equilibrium price of that quote / bid / trade activity. That's why they a credible. That's why they are trusted.
- Forward prices are prices agreed today for delivery in the future. The contract which confirms this transaction, and thereby the forward price, is a forwards contract.
- What much of the steel industry deals in now are forwards. You contract today, and commit to prices today, for steel to be delivered in the future ie a period forward of today.
- So what the steel industry has now are monthly forwards contracts. That it prices (and all technical details) agreed today for delivery within a particular month forward of today. Might be 1 month forward, or 3 months forward, or for international shipments 5 or even 6 months forward.
The only material difference is that futures contracts are standardised. Every contract is the same. Same underlying, same delivery points, same size, same payment terms etc.
Whereas steel's existing forwards contracts allow individual firms to tailor the contracts to fit with their exact needs, futures contracts do not allow such flexibilities. Futures contracts are merely standardised forwards contracts.
Forwards vs Futures Prices
The forwards price - the price contracted to in your forward contract - is usually unique to that deal. So on any day you'll get a range of forwards prices for the same steel, as determined by differences in payment terms, or delivery terms, or packing, or additional testing. You'll even have different prices for the exact same volume of the exact same steel for the exact same delivery, same payment terms etc.
Not with futures. Because futures contracts are all standardised, and not subject to the tailoring of steel's traditional forwards contracts, at any moment in time there is only one price for each delivery period.
Lets just think about the price at which the steel industry's regular forwards contracts are concluded. The price in a forwards contract is the equilibrium price between what the steel mill thinks its steel is worth - the asking price - and what the buyer thinks its worth - the bid price. You negotiate to arrive at the contract price.
In a futures market, instead of
- One seller and one buyer concluding one contract at one unique price, there are
- Lots of sellers and lots of buyers concluding lots of contracts.
Price Credibility
So which price is a better reflection of the market ? Which price is more credible ?
- The unique, tailored forwards contract price negotiated between a single seller and single buyer, maybe with unique product, payment terms, and other tailored attributes. And because there are many such contracts, there has to be some interpretation / value judgement to define a 'forward price', otherwise the forward price can only ever be a range.
- The futures market price, which is the equilibrium level of many thousands of buy-sell contracts, all standardised, and for which there can only every be one price at any moment in time ?
Steel futures prices are not guesswork or hunches or bets. They are the direct result of informed buyers and sellers quoting, bidding, and trading contracts, with firm commitments to make or take delivery of steel. At any one time the futures price for a particular month is the equilibrium price of that quote / bid / trade activity. That's why they a credible. That's why they are trusted.
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